GFT Embraces the ‘Dawn’ of FRTB Requirements

The English romantic poet William Wordsworth once wrote of the heady early days of the French revolution:

“Bliss was it in that dawn to be alive,

But to be young was very heaven! …

The attraction of a country in romance!

When Reason seemed the most to assert her rights.”

A new report from the GFT Group, a Germany headquartered multinational focused on business consulting, information technology consulting, and IT services, is not exactly written in Wordworthian verse, but it is as about as enthusiastic as its subject matter allows. And it even leads with the same metaphor.

Baselian Reason Seems the Most to Assert Her Rights

GFT has provided us with an ode to “the dawning of a new era for market risk management” with the Basel Committee on Banking Supervision’s Fundamental Review of the Trading Book (FRTB).

The goal here is robustness, not sophistication. I’m not sure that Wordsworth understood the difference when he wrote of “Reason” and her rights, but the difference was pounded into the rest of us in 2007-08. The main objectives of the FRTB include the development of a system for calculating capital requirements for banks that will not require rocket science, along with the creation of “a fallback in the event that a bank‘s internal model is deemed inadequate,” thus confirming robustness, and (always the given from a Baselian view of the world) the increase of banking industry consistency across jurisdictions.

The GFT paper contends that although there is still much in flux as to the details of this review, the new regulations coming out of the FRTB process are taking shape, and they will mean great changes for trading desks and the way their capital requirements will be set.

Specifically, the authors – Wolfgang Mantke, Manish Neoliya, John Barclay, and Alan Morley, are enthusiastic that the Expected Shortfall (ES) measure, which is to replace Value-at-Risk computations, will “facilitate a fair risk attribution.”

The gist of the new model for those simplified cap requirements involves subjecting each risk factor to liquidity horizon scaling. This is what is called the “expected shortfall,” that is, the ease or difficulty of unwinding various positions in the markets. ES will correspond to the VaR component in older models. It will complement the use of incremental default risk (IDR) and a capital add-on based on stress testing and scenario analysis.

GFT’s paper stresses that this approach will come with “stringent new requirements on [profit and loss] attribution and back testing” and a revision of the boundary between the banking book and the trading book of a particular institution.

The Benefits of the New Approach

GFT accepts the case for moving away from VaR into ES. It says that ES will improve the capture of tail risk, the black swans’ issue that is “one of the often-cited deficiencies of VaR.” Also, ES offers a reliable tool for identifying the benefits of risk diversification.

Another plus that the latest from Basel offers the banking world is “clearer guidance on the choice of risk factors and how they should be reviewed in terms of adequacy and granularity.”

The authors’ bottom line is this: if banks “fully embrace the requirements of FRTB and capitalize on an efficient new approach, then this could truly be the dawning of a new age for risk management.”

GFT Revenue News

Separately, GFT has released its earnings news through the first three quarters of 2015. In this period GFT’s revenue was $291.23 million, up 42% from the same three quarters in 2014, when revenue was $205.40 million. GFT has increased guidance for the full year from $388.34 million to $394.77 million, with EBITDA and EBT increasing by $1.07 million each to $47.20 million and $33.26 million, respectively.

In its release the company pats itself on the back for recent mergers that, it believes, contributed to this result. It bought a UK based company, Rule Financial Ltd., in June 2014, and a company based in Spain, Adesis Netlife S.L., in July 2015.

Rule Financial was a London based company that offered services for investment banks in Western Europe and North America, especially in the UK and the US. The acquisition was designed to increase GFT’s exposure to those markets.

GFT’s CEO, Ulrich Dietz, said that GFT was then “one of the few listed family businesses with strong German roots.” A combination with Rule would not only strengthen its position in itself, but would lay the groundwork for “much faster organic growth” as well, allowing for “an even more comprehensive portfolio of solutions for the banking sector.”